Overhead: The Good and Bad

Last Friday, Gene was on Nonprofit Radio discussing examples of good and bad overhead following host Tony Martignetti’s interview with the three signatories to The Overhead Myth letter. The growing rejection of the myth that overhead is a good way to measure a charitable organization’s value is a promising trend. The overhead myth has long contributed to nonprofits under-investing in critical aspects of their organization and operation solely to appease donors and board members who bought into the popular longstanding myth.

This is not to say that overhead ratios are unimportant. But, the numbers should be interpreted within the larger context of how the organization is functioning.

As Gene noted on the program, some types of overhead may be better than others. Good overhead expenses advance an organization’s ability to further its mission. Higher overhead ratios, relative to comparable organizations or historic figures, may be justifiable where the organization is building structures and systems to increase its effectiveness and/or efficiency, or to resolve problems that have arisen or previously been unaddressed. Bad overhead expenses do not advance an organization’s ability to further its mission or do so only in an inefficient, non-strategic manner. With recognition that there may be exceptions based on an organization’s unique facts and circumstances, here are some examples:

Good Overhead:

Education. A strong organization ensures that its board and executive are empowered with the information required to do their jobs well. It is far too common for organizational leaders to lack experience in critical areas of governance and management and to allocate insufficient resources for their development. Generally, an organization can only go as far as its leaders take it, so it’s imperative to properly equip such leaders.

Policy Creation. A strong organization is guided by sound policies that help improve its operations, prevent costly mistakes, and keep it legally compliant. Examples of important policies for a nonprofit include those covering: conflicts of interest, document retention and destruction, whistleblowers, gift acceptance, expense reimbursements, contract approval, check-signing, internal controls, investments, employment, social media, and intellectual property.

Risk Management. A strong organization recognizes that “an ounce of prevention is worth a pound of cure” and places value on protecting its leaders, employees, and volunteers. Assessing risks with the help of experts through legal, accounting, and program audits may be invaluable in mitigating risks, preventing waste, and finding new areas of efficiency.

Technology (including information technology). A strong organization invests in tools that help advance its ability to further its mission. Dated technology may be more expensive to maintain, create inefficiencies in productivity, and hinder or prevent expansion. New technology may allow for more effective and/or efficient ways of delivering services, receiving feedback, mobilizing advocacy efforts, measuring and analyzing impact, communicating with donors and other supporters, and finding new donors.

Building engagement and collaboration. A strong organization engages its staff, board, volunteers, allies, and communities. If an organization’s most valuable asset is its people, sufficient investments to recruit and retain the best people for the job are critically important. This relates to compensation, training, communications, workspace, job flexibility, and appreciation among other things. External communications should reflect the values and professionalism of the organization. In budgeting for such efforts, an organization’s leaders must consider the value it places on its public reputation, goodwill and transparency. Such communications may be tremendously important as building blocks for future collaborative efforts, something every organization should be exploring.

Bad Overhead:

Certain insider transactions. Insider transactions that benefit insiders (board members, officers) more than the organization’s intended beneficiaries may be unlawful. But even when they’re not, and even if such transactions merely give the appearance of benefiting insiders more than beneficiaries, an organization should think carefully and consider alternatives before proceeding.

Extravagant expenses resulting in trivial benefits. What is extravagant? What is trivial? Smart organizations will consider these questions from the perspective of their donors and other stakeholders before spending. For some organizations, a $500 daily hotel bill may be acceptable in certain circumstances; for others, it might be considered outrageous and severely harm the organization’s goodwill.

Expenses that further some cause other than your mission. There are many worthy causes, but a charitable organization is legally bound to advance its own stated mission.

Co-authored with Gene Takagi.

About Us

Gene Takagi is the managing attorney of the NEO Law Group. Follow Gene on Twitter @GTak.

Erin Bradrick is senior counsel with the NEO Law Group. Follow Erin on Twitter @erinbradrick.